U.K. government should resist the VC trap
The British government is considering whether to set up a mega public-private fund to invest in early-stage ventures. This would be a mistake. While British — and European — entrepreneurs have largely failed to produce huge successes like Google and eBay, bunging taxpayers’ money at the problem is not the answer.
In a policy document published on April 20, the government said it is evaluating whether to set up a public-private fund with similar objectives to the Industrial and Commercial Finance Corporation, the precursor to 3i. That was established with 10 million pounds in 1945 as Britain struggled to recover from war. Such a move has been urged on Lord Mandelson, the business secretary, by the Confederation of British Industry (CBI), the National Endowment for Science, Technology and the Arts (NESTA) and the British Venture Capital Association (BVCA). NESTA is looking for a 1 billion pounds fund; BVCA for 1 billion pounds-plus and the CBI for a round 1.5 billion pounds. The idea is for the government would lead the fund-raising by putting up an unspecified portion of the total pot.
Venture capital bigwigs speak of a calamity if the state does not step in. Britain risks “a lost generation of innovation”, says Simon Walker, the BVCA’s boss. NESTA warns that the country could lose 44 billion pounds in annual revenues unless it invests in growth businesses. Indeed, Walker believes the government shouldn’t waste time evaluating things and should simply start writing checks. Unless it does so, hundreds of early-stage businesses that need of capital may go to the wall. The BVCA recently published figures showing that investment in British venture capital collapsed by 62 percent from its peak in 2006, to 346 million pounds last year. Whether this had anything to do with the investment decisions that venture capitalists made in this period, BVCA didn’t say.
However, the industry’s argument that there is an “equity gap” that the government should fill is hokum. Returns to venture capital in Britain — and more broadly in Europe — have been dire.
The BVCA says that the median net internal rate of return between 1980 and 1997 (it would not give figures younger than 12 years old, though the returns turned negative over the tech bubble years) was 9 percent. This is a pretty mediocre given the riskiness of the sector. The picture across Europe is even worse. Data from Thomson Reuters and the European Venture Capital Association show an annual net internal rate return to investors of -1.1 percent (yes, minus 1.1 percent) from early-stage venture capital over twenty years to the end of 2008. Industry insiders say these numbers put European VC consistently at the bottom of the private equity heap.
Indeed, against this backdrop, it’s quite impressive that investors were willing to stump up 346 million pounds in British VC in 2008. Moreover, this number only looks low compared to the bubble years of 2006 and 2007.
Indeed one could even argue that, given the dismal returns, too much has been invested in European VC rather than too little. The problem may rather be cultural, or stem from excessive red tape. After all, European science if widely regarded to be up to that in America, but Europe has not turned that research into Google or an eBay yet (though Index, the darling of the sector, did a very good job flogging Skype to eBay).
There have been lots of reasons advanced for why U.S. VC has performed much better than Europe: the cluster of high-tech around Silicon Valley, a sophisticated and supportive venture capital industry, the bigger scale of the U.S. market or simply the American “can do” attitude. No one has claimed that it is because insufficient American taxpayers’ money has been put into venture capital. Mandelson should keep private equity’s hands out of taxpayers` pockets.